Edward Jones & Co. has halted the sale of leveraged ETFs, citing the products as "misunderstood and potentially dangerous." A July 21 Wall Street Journal article reports that the St. Louis-based firm stopped selling the enhanced funds, which are designed for use by sophisticated daily investors, not long-term holders.As the ETF industry continues to grow, this announcement will hopefully help to sharpen its focus. Investors who seek out ETFs for their low cost structure and transparent nature may have difficulty in the current ETF sales environment telling the difference between traditional and non-traditional ETF products. Edward Jones decided in its June review of investment products to cut leveraged ETFs from the lineup. Edward Jones mutual fund research analyst Katie Martin authored a report titled "not all ETFs are created equal," citing the dangers of exchange-traded notes and structured products with similar methodologies to leveraged ETFs. "Investors also need to recognize that leveraged ETFs have an increased potential for capital gains distributions and significantly higher expense ratios than the traditionally broadly based stock market ETFs, negating some of the benefits of purchasing an ETF," noted the Edward Jones report, as quoted in The Wall Street Journal article. Edward Jones hit the nail on the head when it cites that the realities of leveraged funds are "negating some of the benefits of purchasing an ETF." It is crucially important for investors to understand how ETF issuers and traders pay their rent -- and it isn't typically just from traditional ETFs. (See "Hedging Your ETF Bets.")
It is important to remember that "ETFs" have spent more than a decade establishing themselves as transparent, low-cost products. New, exotic, high-cost ETF strategies are masquerading as approachable funds and could dupe investors. Both FINRA and the Massachusetts attorney general have recently made headlines highlighting the potentially dangerous nature of the funds. Schwab ( SCHW), whose "asset management and administration" unit accounted for a whopping 46% of revenue, recently announced that it would be offering its own line of proprietary ETFs in the near future. This move could be a reoccurring theme in the asset management universe, as beaten-down investors clamor for transparent, cheaper alternatives for their portfolio Schwab will not begin its ETF line with a "Schwab 10x Short S&P" ETF, but rather more traditional products. Investors must keep their eyes open, however, as the industry moves forward. Quite simply, more complicated ETFs command higher fees and benefit sophisticated traders on the other side of the transaction. During the housing meltdown, unwitting investors bought AAA rated securities that were comprised of complicated, inappropriate investment instruments. Haven't we learned our lesson? Brokers, dealers and issuers need to stop categorizing complex products alongside viable long-term investment strategies before ETFs become more entrenched into recovering 401-k portfolios. ETF products should be categorized depending on their strategy. A fund that tracks a regular basket of domestic equities should not be viewed in the same category as a fund that tracks swaps and futures contracts. Traditional ETFs should be separated from non-traditional ETF products such as leveraged funds, ETNs and futures-based commodity funds like United States Oil ( USO) and United States Natural Gas ( UNG).